Navigating the stock market often feels like trying to make sense of chaos. You might see outstanding companies with stagnant stock performance while companies that are less commendable experience stock price surges. It’s baffling.
For those of us involved in trading and investing, finding a method to decode this unpredictability is essential.
When I first started out, I was struggling to find my footing. I devoured every book on company analysis that I could get my hands on, and made it a point to read Investor’s Business Daily and The Wall Street Journal religiously. I felt confident in predicting market movements and individual stock tendencies—yet reality often had other plans.
The disconnect between knowledge and successful application was frustrating, to say the least.
Then, by a stroke of luck, I enrolled in a course on technical analysis, which taught me how to identify patterns within the stock market.
That was the turning point for me.
“I See Patterns”
Much like Haley Joel Osment hesitated to reveal his secret in The Sixth Sense, I too was initially slow to embrace the patterns I started spotting. My focus had been on fundamental factors like price-to-earnings ratios and operating margins—tools I’d been taught were essential for making profits in the market.
But once I realized how these patterns could guide my decisions on when to buy or sell, I quickly leaned into this new approach.
Patterns come in various forms.
One prominent example is the head and shoulders formation on a stock chart.
This particular pattern signals a bearish trend. It forms when a stock hits a consistent level called the "neckline" after peaking three times, with the middle peak (or "head") surpassing the heights of the adjacent peaks ("shoulders").
In the scenario depicted, your fundamental analysis might have suggested in late June that this stock had great value, predicting a rise in earnings and marking it as a desirable buy.
However, spotting a head and shoulders pattern on the chart might have prompted a pause for reconsideration. Recognizing this pattern would suggest the stock might dip, offering a better buying opportunity later.
Your fundamental analysis might have indeed been long-term accurate. Yet, by interpreting these patterns, you could have avoided the cost—and stress—of holding the stock during its decline.
Not all significant patterns appear on stock charts. Take the old saying “sell in May and go away,” for instance.
This expression highlights that stock performance historically fares better from November to April compared to May through October.
In the 20th century, the S&P 500’s monthly returns averaged 1.05% from November to April, contrasted with 0.27% from May to October.
Since 1990, the trend has continued, with stocks averaging a 7% return from November to April and just 2% from May to October.
You’ll find numerous patterns repeating through the years, from market trends during presidential cycles to performance based on transaction timing, such as day or month.
While patterns aren’t foolproof predictors, history has a tendency to rhyme. Stock and market movements are often driven by human emotions, a constant influence over time. Leverage these patterns, and you’ll likely improve your trading success.
If you’re not already factoring patterns into your trading strategy, it’s time to start learning. Your broker’s website probably contains a wealth of valuable, complimentary material.
Recognizing market patterns fundamentally altered my approach to trading. It turned disarray into method and enhanced my profitability as both a trader and investor.
